The Pension Protection Act of 2006: Legalizing the Cash Balance Plan

This letter is part of a series (2 of 10) on cash balance retirement plans, one of the best strategies to help high-earning Americans reduce taxes and accelerate their retirement savings. Since the loosening of IRS restrictions in recent years, cash balance plans have become extremely popular and only continue to grow, commanding over $1 trillion in assets. Adding a cash balance plan on top of a 401(k) profit-sharing plan can generate hundreds of thousands of dollars in annual tax savings.

The Pension Protection Act of 2006 established the cash balance plan as a viable and legally recognized retirement savings option. Before 2006, cash balance plans faced frequent legal challenges. Those bringing the lawsuits argued that cash balance plans violated the rules for benefit accrual and discriminated against older workers. The rulings on these cases were inconsistent, and many business owners didn’t want to risk establishing a plan that simply didn’t have firm legal footing.

The Pension Protection Act ended this legal uncertainty and set a few specific requirements for cash balance plans, including:

?  Clarification on age discrimination claims: A cash balance plan does not violate age discrimination legislation if the account balance of an older employee is equal to or greater than that of a similarly situated younger employee (i.e. with the same length of employment, pay, job title, date of hire, and work history).

?  A vesting requirement: Any employee who has worked for their company for at least three years must be 100% vested in their accrued benefits from employer contributions.

?  A change in the calculation of lump sum payments: Participants can usually choose to receive a lump sum upon retirement or termination of employment instead of receiving monthly payments. Before 2006, some plans used one interest rate to calculate the anticipated account balance upon retirement but, if a participant opted to receive a lump sum, used a different interest rate to discount the anticipated retirement balance back to the date of the lump sum payment. This led to discrepancies between the hypothetical balance of the account and the actual lump sum payout, an effect known as “whipsaw”. The Pension Protection Act eliminated the whipsaw effect.

There are, of course, many other points included in this lengthy piece of legislation, but the takeaway is this: the Pension Protection Act of 2006 removed the legal uncertainty surrounding cash balance plans and made them a much more appealing option for small business owners. According to Kravitz Inc., the number of cash balance plans in America more than tripled after the implementation of the Pension Protection Act. Additional regulations in 2010 and 2014 made these hybrid plans an even better option, and their popularity only continues to grow. There are thousands of high-earning business owners who can reap huge, tax-crushing benefits from implementing cash balance plans . . . you just have to know about them first.

William Hall III

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